# Petition for Writ of Certiorari — Commissioner v. Clark > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385012_0634%3A2 ## Record - **Collection:** Supreme Court brief - **Document type:** Petition for Writ of Certiorari - **Published:** January 1, 1989 - **Citation:** 489 U.S. 726 ## Text In the Supreme Court of the Ani OCTOBER TERM, 1987 COMMISSIONER OF INTERNAL REVENUE, PETITIONER v. DONALD E. CLARK AND PEGGY S. CLARK PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT DONALD B. AYER Acting Solic:tor General WILLIAM 38. ROSE, JR. Assistani Atiorney General LAWRENCE G. WALLACE Deputy Solicitor General ALAN I. HOROWITZ Assistant to the Solicitor General ERNEST J. BROWN Altorney Departmer: of Justice Washingtor D.C. 20530 (202) 633-2217 QUESTION PRESENTED In this case, a relatively small corporation was merged into a subsidiary of a large publicly-owned corporation, and the sole shareholder of the acquired corporation received in exchange for his shares both cash and shares of the stock of the publicly-owned corporation. The question presented is whether that payment of cash had the “effect of the distribution of a dividend” within the meaning of Section 356(a)(2) of the Internal Revenue Code. (1) TABLE OF CONTENTS Page EE EEE ee ee ay ae | ec eee ed nd Ge awe 60 04ers b0e60 00 sede | RT NE occ cc ccc etccceccccss Sora eeErT rae : 2 Gn 2 Reasons for granting the petition ......................... 6 hai anid nw oy 0'0's 0060 08000 ee Betis 'sia ieee 23 EE io 64 Beg bode dcnlsko ce cae ts ae aia koe la ee ee ee hss 6 ba eaedcnat ear 15a a ce et ee oie a oS bls ee gis k wah 40a a cl Cub vbcbboeenaetesei eke se. or ae TABLE OF AUTHORITIES Cases: Baker v. United States, 460 F.2d 827 (8th Cir. 1972)... .. 22 Campbell v. Commissioner, 144 F.2d 177 (3d Cir. MC ACh Cece: 6 ou wire h ebmee 6b Oss eee 6s. . 8, 15, 16 Commissioner v. Estate of Bedford, 325 U.S. 283 (1945) . 16, 17 Commissioner v. Forhan Realty Corp., 75 F.2d 268 (2d RN a ee Te i elcek eee bebe 15 Commissioner v. Gordon, 391 U.S. 83 (1968)... 0000... 12 Commissioner Vv. Munter, 331 U.S. 210 (1947) 2000000... 11 Commissioner v. National Alfalfa Dehvdrating & Milling Ne ce vaceeeceeuces 20 Commissioner v. Owens, 69 F.2d 597 (Sth Cir. 1934) .... 14, 16 Commissioner Vv. Phipps, 336 U.S. 410 (1949) 200... 1] DeGroff v. Commissioner, 444 F.2d 1385 (Oth Cir. I ea 1S Don E. Williams Co. v. Commissioner, 429 U.S. 569 EE ee ee Estate of Uris v. Commissioner, 605 &.2d 1258 (2d Cir. SS oe ee ee pean : 22 Foster vy. United States, 303 U.S. 118 (1938) ae, li, 22 General Housewares Corp. v. United States, 615 &.2d va Le 5 iia il, 16 Hawkinson v. Commissioner, 235 &.2d 747 (2d Cir. ee ew kas i; ewes us 8, 15,17 (111) BEST AVAILABLE COPY IV y Cases-Continued: Page Statutes and regulation-Continued Page Idaho Power Co. v. United States, 161 F. Supp. 807 (Ct. : Cl.), cert. denied, 358 U.S. 832 (1958) ............-.- 16 — . ; aor Partie el a1. 8, ae . Kine Sescnpeiees, Onc. v. eed ees, MORIN i a RE Ba 8, 15, 17 Revenue Act of 1921, ch. 136, 42 Stat. 227............, 12 Lewis v. Commissioner, 176 F.2d 646 (Ist Cir. 1949) .. 13, 15-16 § 202(c{2), 42 Stat. 230 ........... eee eee, 13 Liddon v. Commissioner, 230 F.2d 304 (6th Cir.), cert, § 202(d)(1), 42 Stat. 230... 0... eee eee, 13 ao ee 15 Revenue Act of 1924, ch. 234, § 203(d), 43 Stat. 257... .. 13 Love v. Commissioner, 113 F.2d 236 (3d Cir. 1940) ...... 16 ee tae: 13 Pridemark, Inc. v. Commissioner, 345 F.2d 35 (4th Cir. DEED -cneSssboepecsaveccanan «06 6eesk buns see e4ess 16 Miscellaneous: Rose v. Little Investment Co., 86 F.2d 50 (Sth Cir. 1936) .. 15 Ross v. United States, 173 F. Supp. 793 (Ct. C1.), cert. Darrell, The Scope of Commissioner vy. Bedford Estate, denied, 361 U.S. 875 (1959) ...........00.00005: 15, 16, 17 eR See ee 17 Sheldon v. Commissioner, 6 T.C. 510 (1946) . 2.0... 5... 15 H.R. Rep. 179, 68th Cong., Ist Sess. (1924) ............ 13 Shimberg v. United States, 577 F.2d 283 (Sth Cir. 1978), H.R. Rep. 99-841, 99th Cong., 2d Sess. Pt. I (1986)... y cert. denied, 439 U.S. 1115 (1979) .... 4, 6, 7, 8, 16, 17, 18, 19 United States v. Davis, 397 U.S. 301 (1970) . 2... 2... ee. 19 Rev. Rul. 74-515, 1974-2C.B. 118 ........... 0 eee 7 woadward v. Commissioner: Rev. Rul. 74-516, 1974-2C.B. 121 .................... 17, 20 ee one a a cena kh dkmaee oh 15, 16 S. Rep. 275, 67th Cong., Ist Sess. (1921)... 00002... 13 30 B.T.A. 1216 (1934) . pla beeing tettee eee 15 S. Rep. 398, 68th Cong., Ist Sess. (1924) ....0.00.00.... 13 Wright v. United States, 482 F.2d 600 (8th Cir. 1973) .. 4, 17, 18 Shoulson, Boot Taxation: The Blunt Toe vf the Auto- matic Rule, 20 Tax L. Rev. 573 (1965)... 0.2.0.6... 17 Statutes and regulation: Internal Revenue Code (26 U.S.C.): 0 AA rere rr mre rT Te me re erie S 4 SSSA IPE OTT CCCP RCLTET Pelee eee 0 A rere hee ery ee 5 RED os 6 oce'daecuheses kbeeseee@esEb eran ers 19 EE bas 6k 6h Waeeney see 006 oR eee eEseeR ee 2, 12 6 | UEP Ore eT A rrr eer rr on et ye 7 vaca btdude Kaka eee eee seh 2, 12 EE ro es ca wie bbe ce eee cee htaeh ee Cenaeereees 2, 13 EN Gi kad evacovb ead ae 600 vee Ne es eee naan Tee 2 SE, is obs eee wend eea eens ceabeaneeteded 13 NG ak eae a cae oN 4,6, 10, 11, 14, 17, 19, 20, 22 a wt sa od ole des see eeMEM PAO eng f 13 i ek 6 old Wane RAR ROURS SEETS he 13 I so Se le ees 6 ow a Oe eR EES eae PF «ee! ferry cae eee ee Te 14 ST ne Ski heen hath PERE O Eee CEES 15 Jn the Supreme Court of the United States OCTOBER TERM, 1987 No. COMMISSIONER OF INTERNAL REVENUE, PETITIONER Vv. DONALD E. CLARK AND PEGGy S. CLARK PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT The Solicitor General, on behalf of the Commissioner of Internal Revenue, petitions for a writ of certiorari to review the judgment of the United States Court of Appeals for the Fourth Circuit in this case. OPINIONS BELOW The opinion of the court of appeals (App., infra, la-14a) is reported at 828 F.2d 221. The opinion of the Tax Court (App., infra, 15a-39a) is reported at 86 T.C. 138. JURISDICTION The judgment of the court of appeals (App., infra, 40a) was entered on September 4, 1987. On November 24, 1987, the Chief Justice extended the time for filing a peti- tion for a writ of certiorari to and including January 2, 1988. On December 17, 1987, the Chief Justice further ex- tended the time for filing a petition for a writ of certiorari to and including January 11, 1988. The jurisdiction of this Court is invoked under 28 U.S.C. 1254(1). (1) STATUTE INVOLVED The relevant portions of Sections 302, 316, 317, 354, and 356 of the Internal Revenue Code (26 U.S.C.) are set forth in a statuiory appendix (App., infra, 41a-45a). STATEMENT For some time prior to April 1979, respondent Donald E. Clark! was the president of Basin Surveys, Inc., a West Virginia corporation that furnished radiation, nuclear, and electronic open-hole logging services to the petroleum industry, and he owned all of its outstanding 58 shares of stock. N.L. Industries, Inc. (NL) was then a publicly-held New Jersey corporation engaged in manufacturing and supplying petroleum equipment and services, chemicals, and metals. NL had outstanding approximately 32,533,000 shares of a single class of common stock and 500,000 shares of preferred stock. That stock was publicly traded on the New York and Pacific Stock Exchanges. N.L. Acquisition Corp. (NLAC) was a wholly owned sub- sidiary of NL. App., infra, 16a. In 1978, NL had initiated discussions with respondent concerning the possible acquisition of Basin. After several months of negotiations, NL offered respondent alter- native terms for the acquisition of Basin: (1) 425,000 shares of NL common stock without cash; or (2) 300,000 shares of common stock and $3,250,000 in cash. Respond- ent decided in favor of the latter alternative. App., i/ra, l6a.? ' Respondent Peggy S. Clark is a party herein only because she filed a joint federal income tax return for the calendar year 1979 with her husband, respondent Donald E. Clark. References to “respondent” in the singular will be to Donald E. Clark. >In the Tax Court, respondent’s attorney testified (and it was agreed that, if called, respondent would tesitfy to the same ettect) that, after receiving NL’s alternative offers, respondent had requesied 3 On April 3, 1979, an agreement and plan of merger was executed by Basin, NLAC, NL, and respondent. The plan provided that, on April 18, 1979, Basin would merge with and into NLAC, which would change its name to Basin Surveys, Inc., and that respondent would receive, with respect to each of the 58 shares of Basin that he owned, 5,172.4137 shares of NL common stock and $56,034.482 in cash. The merger took place as planned. Respondent received 300,000 shares of NL common stock and $3,250,000 in cash, and ne entered into an employment agreement with Basin Surveys, Inc., for three years and an agreement not to compete for five years. The parties stipulated that the merger of Basin into NLAC was ef- fected pursuant to, and qualified as a reorganization under, Section 368(a)(1)(A) and (a)(2)(D) of the Internal Revenue Code.? App., infra, 16a-17a. 2. Section 356(a)(1) of the Code provides that, if cash or other property is received in the course of what would otherwise be a tax-free, stock-for-stock reorganization, the recipient must recognize his gain on the transaction up to the value of that other property received. Accordingly, in their joint federal income tax return for 1979, respondents reported the cash received in the merger, com- the NL representatives to leave the room, so that the two of them could discuss the matter. In that discussion, the factors that led to a tentative choice of the latter alternative were that respondent’s “whole livelihood was tied up in his company,” and that an all-stock deal would involve the risk of serious loss if something happened to NL. Moreover, the stock of NL that was to be received would not be registered stock, but would be restricted letter stock, which would mean, under SEC rules, that respondent would have to hold the stock tor a couple of years if he wanted to sell it and receive full value. And, in view of respondent’s complete involvement with his company, that, in turn, would have meant that he could not pay his outstanding bills. C.A. App. 48-53. * Unless otherwise noted, all statutory references are to the Internal Revenue Code (26 U.S.C.), as amended (the Code or 1.R.C.). 4 monly known as “boot,” as taxable gain.* They characterized this amount as long-term capital gain. Sec- tion 356(a)(2) of the Code, however, requires that, if the exchange “has the effect of a distribution of a dividend,” the recipient must treat the property received as a dividend to the extent of his ratable share of the undistributed earn- ings and profits of the corporation accumulated after February 28, 1913. Under this Section, the Commissioner determined that $2,319,611 of the reported gain (i.e., the amount of the accumulated earnings and profits of Basin at the time of the merger) should be treated as a dividend and therefore taxable as ordinary income rather than as capital gain. This determination resulted in an asserted deficiency of $972,504.74 in federal income taxes for 1979. 3. Respondents petitioned for review in the [ax Court, which ruled in their favor in a reviewed decision (App., infra, 15a-39a). The court viewed the question whether respondents’ receipt of cash in the merger had the effect of the distribution of a dividend as turning on a choice between two “judicially articulated tests” set forth in Wright v. United States, 482 F.2d 600 (8th Cir. 1973), and Shimberg v. United States, 577 F.2¢ 283 (Sth Cir. 1978), cert. denied, 439 U.S. 1115 (1979) (App., i/ra, 18a). According to the Tax Court, the Shimberg test would treat the cash distribuiion as if it constituted a distribution by the acquired corporation prior to the merger, and the Wrighs test would treat the cash payment as if it constituted “a distribution by the acquiring corpora- tion (NL) in a hypothetical redemption of the shares of NL stock that would have been received if petitioner had ac- +The figure reported by respondents on their return Was $3,195,294. In their later computation for entry of decision by the Tax Court, respondents acknowledged that the amount of gain recognized and reported should have been $3,250,000. cepted stock in lieu of the cash consideration” (App., in- fra, 18a (emphasis in original)). The Tax Court then concluded that it should follow Wright and treat the cash payment as part of a post- merger hypothetical redemption of the 125,000 shares of NL stock that respondent declined to accept as payment. The court stated that this approach was necessary if the cash payment is to “be viewed and tested within the con- text of the entire reorganization” (App., infra, 33a). Because such a hypothetical redemption would have reduced respondent’s holdings in NL from 425,000 to 300,000, it would nui have been essentially equivalent to a dividend under the redemption provisions of the Code (see Section 302(b)(2)).° Under the Tax Court’s approach, this conclusion meant that the cash received by respondents should not be viewed as a dividend in the reorganization context either, and therefore respondents were entitled to capital gain treatment upon the reported gain. App., in- Sra, 34a-35a. 4. The court of appeals affirmed (App., infra, la-14a). Like the Tax Court, the court of appeals ap- proached the case as requiring it to choose between Wright and Shimberg (see App., infra, 8a). The court first con- cluded that the dividend determination was to be made by importing into the reorganization context the principles applicable to redemptions under Section 302 of the Code (App., infra, 3a-6a). The court then concluded that the tests of Section 302 should be applied as if there had been a hypothetical redemption after the reorganization was ; Under the “safe harbor” provisions of Section 302(b)(2), cash received upon a “subtantially disproportionate redemption” will not be treated as a dividend. The statute defines such a redemption as one in which the shareholder’s percentage interest in voting stock in the corporation following the redemption is less than 80% of what it was before the redemption and he retains less than 50% of the voting power in the corporation following the redempiion. 6 completed, and hence that whether the cash payment was a dividend turned on the extent of the reduction in respondent’s interest in NL occasioned by the hypothetical redemption (App., infra, 7a-1la). The court criticized the Shimberg approach of treating the cash payment as being made by the acquired corporation (App., infra, 10a-14a), stating, inter alia, that it failed adequately to consider “the corporate control he retained after the reorganization was completed” (/d. at 10a-11a). REASONS FOR GRANTING THE PETITION The court of appeals’ decision in this case has created a clear conflict in the circuits with respect to the treatment under Section 356(a)(2) of the Code of cash or other prop- erty received in a reorganization. This conflict, if allowed to persist, will create severe administrative problems for the Internal Revenue Service. Depending on their situa- tion, different types of shareholders have different preferences for the treatment of the cash that they receive in a reorganization. Accordingly, regardless of which of the court of appeals decisions that it follows, the IRS can expect some taxpayers to challenge its treatment. Unless the conflict is resolved, therefore, the issue presented here is destined to remain a continual source of dispute and litigation. Moreover, the decision below unjustifiably departs from a long line of contrary authority on a recur- ring issue on which there are frequently large sums of money at stake. For these reasons, it is appropriate for this Court to grant certiorari to resolve the conflict. 1. There can be no doubt that the decision below directly conflicts with Shimberg v. United States, 577 F.2d 283 (Sth Cir. 1978), cert. denied, 439 U.S. 1115 (1979). As the Tax Court noted (App., infra, 27a), Shimberg in- volved “a factual set of circumstances similar to the instant case,” and there is no principled basis for reaching a dif- ferent result in the two cases. In Shimberg a smaller cor- Rr nme eR 7 poration was merged into a larger one, and the shareholders of the acquired corporation received shares in the acquiring corporation, plus $625,000 in cash, to be allocated among the shareholders on a pro rata basis. Shimberg, who owned a majority of the shares of stock in the acquired corporation, reported his share of the cash received as long-term captial gain, but the Commissioner determined that it should be taxed as a dividend. The court of appeals in Shimberg rejected the taxpayer’s contention that redemption principles— namely, whether receipt of the cash in a hypothetical redemption of his shares in the acquiring corporation would have resulted in a meaningful reduction of his interest in that corpora- tion — should be applied to determine whether the cash was equivalent to a dividend. The court stated (577 F.2d at 287 (footnote omitted)): “We agree with the government that ‘the undifferentiating invocation of stock redemption principles in a reorganization case’ such as this one is er- roneous, and we decline to apply on a wholesale basis the ‘meaningful reduction’ test in cases arising under §356(a)(2).” Rather, the court explained, a “dividend” is generally defined by Section 316(a) of the Code as “any distribution of property made by a corporation to its shareholders * * * out of its earnings and profits.” Ac- cordingly, “[iJf a pro rata distribution of profits from a continuing corporation is a dividend, and a corporate reorganization is a ‘continuance of the proprietary in- terests in the continuing enterprise under modified cor- porate form,’ it follows that the pro rata distribution of ‘boot’ to shareholders of one of the participating corpora- tions must certainly have the ‘effect of the distribution of a dividend’ within the meaning of § 356(a)(2).” The court concluded that “§ 356(a)(2) requires a determination of whether the distribution would have been taxed as a divi- dend if made prior to the reorganization or if no reorganization had occurred.” 577 F.2d at 288. 8 It is evident that the holding of Shimberg is precisely the contention that was rejected here, and, as the court of ap- peals apparently recognized (see App., infra, 7a-8a, 13a-14a), the two decisions are irreconcilable. Moreover, the decision below also conflicts with the decisions of other courts of appeals relied upon in Shimberg (see 577 F.2d at 288) that recognized the appropriateness of divi- dend treatment in situations parallel to that presented here. See, e.g., King Enterprises, Inc. v. United States, 418 F.2d 511, 521 (Ct. Cl. 1969); Hawkinson v. Commis- sioner, 235 F.2d 747, 751 (2d Cir. 1956); Campbell v. Commissioner, 144 F.2d 177, 181-182 (3d Cir. 1944); see pages 14-16, infra. Thus, unless the Court grants certiorari here, different taxpayers will receive disparate tax treat- ment on the same transaction depending upon the circuit in which their case arises. 2. The conflict in the circuits created by the decision below will create substantial administrative problems for the IRS unless it is resolved. The issue presented here is one on which the respective interests of individual shareholders and corporate sharehclders have long been sharply divergent. At least since 1936, because of the tax advantages of capital gains as opposed to ordinary in- come, it has been in the interest of individual shareholders, like respondents, not to have dividend treat- ment for gain recognized on boot received on a reorganization. On the other hand, corporate shareholdeis participating in the same or similar transactions have preferred to have such gain treated as a dividend, because of the deduction for intercorporate dividends allowed by Section 243 of the Code (generally 85% under present law). Thus, even if the Commissioner were to abandon his longstanding position on this issue and were to adopt the approach taken by the court below, that would not put an end to the controversy over the treatment of boot. It can reasonably be anticipated that corporate shareholders, ewe 9 relying on Shimberg and the cases cited therein, would challenge the Commissioner’s new position and argue for dividend treatment. Thus, the only way to end the con- troversy over the issue presented in this case is by means of a definitive resolution of the conflict in the circuits. In the wake of the Tax Reform Act of 1986, which eliminated the differential tax rates between capital gains and ordinary income, one can expect a significant diminu- tion in the number of individual shareholders whose in- terests will be adversely affected by dividend treatment of boot.® There will, however, remain shareholders in this category; individuals who have, or can carry forward, capital losses on other transactions will want their gain in a reorganization to be classified as capital gain, rather than as a dividend, so that they will be able to take a full deduc- tion for the capital losses (see I.R.C. § 1211(b)). The 1986 Act will not affect the interests of corporate shareholders. Because of the intercorporate dividend deduction, they re- tain the same interest in contesting any effort by the Com- missioner to deny dividend treatment to gain recognized on boot received in a reorganization. Moreover, quite apart from the question of the char- acterization of the gain recognized by the shareholders of the acquired corporation, the conflict in the circuits injects considerable uncertainty into the treatment of other im- portant tax accounts. The court below has held that “the boot should be characterized as a post-reorganization stock redemption by N.L.” (App., infra, 7a). If that characterization is followed, it would necessitate several * Congress, however, apparently viewed the elimination of the dil- ferential tax rates tor capital gain and ordinary income, which had been part of the revenue laws since 1921, as something of an experi- ment. Congress stated that it Was retaining the existing statutory siruc- ture for capital gains in the Code in order “to facilitate reinstatement of a capital gains rate differential if there is a future tax rate increase.” H.R. Rep. 99-841, 99th Cong., 2d Sess. Pt. Il, at 106 (1986). 10 adjustments because, as discussed in detail infra (at 21-22), the receipt of additional stock that is subsequently redeemed has different collateral consequences from the receipt of boot. The receipt of additional shares in the transaction, which has the effect of spreading thinner the total basis transferred from the surrendered shares, means that the basis of each individual share retained after the merger would be smaller than if the boot were character- ized as a dividend. And because the gain recognized on a redemption is reduced by the basis of the redeemed shares, the gain recognized in the merger will be different depen- ding on whether the boot is characterized as a post- reorganization redemption. See pages 21-22, infra. The disparities created by the conflict are even more pronounced in connection with the earnings and profits accounts. Under Section 356(a)(2) dividend treatment, the accumulated earnings and profits of the acquired corpora- tion would be depleted by the amount of the dividend, and those earnings and profits would not be available for future dividends issued by the reorganized entity. On the other hand, if the boot is treated as coming from a hypothetical post-reorganization redemption, the earnings and profits of the acquired corporation ought to survive in the reorganized entity. Instead, the redemption presumably would draw upon the earnings and profits of the corporation whose stock was being redeemed; on the facts of this case, for example, that would lead to a substantially different post-reorganization earnings and profits structure (see pages 21-22, infra).’ Thus, the dif- ’ Moreover, if the transaction is truly to be treated as a redemption, there would be additional differences because a redemption may draw upon capital and upon both accumulated earnings and profits and also those for the taxable year, whereas a Section 356(a)(2) dividend draws only upon accumulated earnings and profits. See page 22, in/ra. RR ee ference between treating the boot as a dividend issued by the acquired corporation, on the one hand, and as a hypothetical post-reorganization redemption, on _ the other, may be reflected in continuing accounts, like basis and earnings and profits, that will have tax effects —and may lead to disputes — many years after the reorganization is complete.* Accordingly, it is of considerable importance for the Commissioner to know at the outset how to treat these transactions and to be able to apply a uniform rule nationwide. In sum, the 1986 Act does not eliminate the need to resolve the conflict in the circuits in order to per- mit the Commissioner to avoid an administrative quan- dary. Moreover, while it is possible that litigation in this area will increase now that the Fourth Circuit has flatly rejected a published IRS position that has been accepted by several courts, it must be emphasized that the administrative dif- ficulties caused by this conflict would not be restricted to the litigation arena. The area of corporate reorganizations is One that involves considerable planning and often in- cludes a request for a private letter ruling from the IRS. The IRS reports that it has issued 190 letter rulings since 1982 on reorganizations involving boot; 110 of these con- tained explicit rulings on treatment of boot under Section 356(a)(2). Each ruling for a particular reorganization will be applicable to an undisclosed, often large, number of shareholders. And a single reorganization may involve both corporate and individual shareholders, whose in- terests will likely be at odds, and shareholders who reside in different circuits, where the precedent governing the treatment of boot is irreconcilable. It is essential for the IRS to have a uniform rule to apply in issuing these rulings. * See, e.g., Commissioner v. Phipps, 336 U.S. 410 (1949); Commis- sioner v. Munter, 331 U.S. 210 (1947); Foster v. United States, 303 U.S. 118 (1938). 3. The court of appeals erred in refusing to treat the boot received by respondents as a dividend. Section 316 of the Code provides that “the term ‘dividend’ means any distribution of property made by a corporation to its shareholders (1) out of its earnings and profits accumu- lated after February 28, 1913, or (2) out of its earnings and profits of the taxable year * * *.” It further provides that “fe]xcept as otherwise provided in this subtitle, every distribution is made out of earnings and profits to the ex- tent thereof * * *.” Section 317 in turn defines “property” for these purposes as “money, securities, and any other property.” The Court summarized the effect of these pro- visions as follows (Comsnissioner v. Gordon, 391 U.S. 83. 88-89 (1968) (footnote omitted)): Under §§ 301 and 316 of the Code, and subject to the specific exceptions and qualifications provided in the Code, any distribution of property by a corporation to its Shareholders out of accumulated earnings and profits is a dividend taxable to the shareholders as or- dinary income. Every distribution of corporate prop- erty, again except as otherwise specifically provided, “is made out of earnings and profits to the extent thereof.” The reorganization provisions of the Code have their origin in the Revenue Act of 1921, ch. 136, 42 Stat. 227. In order to “permit business to go forward with the readjust- ments required by existing conditions without the im- mediate imposition of taxes” (S. Rep. 275, 67th Cong., Ist Sess. 11 (1921)), Section 202(c)(2) of that Act (42 Stat. 230) provided that no gain or loss should be recognized upon an exchange of stock or securities in One corporation that is a party to the reorganization for stock or securities in another corporation that is a party to the reorganiza- tion. Section 202(d)(1) (42 Stat. 230) instead provides that the stock or securities received on the exchange should take the same basis in the hands of the taxpayer as ihe sur- 13 rendered stock or securities. This statutory structure (now codified in I.R.C. §§ 354, 358 and 368) embodies the prin- ciple that such a stock-for-stock reorganization is “a con- tinuance of the proprietary interests in the continuing enterprise under modified corporate form” (Lewis v. Commissioner, 176 F.2d 646, 648 (1st Cir. 1949)). See also Treas. Reg. § 1.368-1(b). In 1924, Congress refined the reorganization provisions that it had enacted three vears earlier by addressing the treatment of a payment of cash, in addition to the stock or securities received tax-free, to the shareholders of one of the reorganizing corporations. It enacted the predecessor to Section 356(a) of the Code, Section 203(d) of the Revenue Act of 1924, ch. 234, 43 Stat. 257, which provid- ed that (1) if, in addition to eligible stock or securities, money or other property was received on a reorganization exchange, gain should be recognized to the extent of that money or other property, but (2) if such a distribution “has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee” the amount of the gain that does not exceed his share of undistributed earnings and profits. Congress indicated that this provision was necessary to account accurately for distributions in the context of a reorganization that had the same effect “as if the corporation had declared out [the cash] as a dividend” directly without the reorganization. See H.R. Rep. 179, 68th Cong., Ist Sess. 15-16 (1924); S. Rep. 398, 68th Cong., Ist Sess. 15-16 (1924). The logical import of all of these provisions is that boot in a reorganization that is distributed pro raia to the share- holders of one of the corporations should be treated as a dividend. A pro rata distribution of cash from a corpora- tion to its shareholders is the classical form of dividend. And the reorganization provisions are designed to reflect the fact that the new corporation is a continuation of the Same enterprise of the acquired corporation. Accordingly, 14 the pro rata “distribution of property” made in the course of the reorganization to the shareholders of one of the cor- porations almost falls within the specific terms of the definition of “dividend” in Section 316 and should be viewed as “essentially equivalent to a dividend” within the meaning of Section 356(a)(2). In this vein, a long line of court of appeals’ decisions in the wake of the 1924 Act recognized that, where two cor- porations not previously under common control are uni- fied either by statutory merger or consolidation (I1.R.C. § 368(a)(1)(A)) or by the transfer of substantially all of the assets Of one to the other in exchange for voting stock of the latter (1.R.C. § 368(a)(1)(C)), and the shareholders of one or both corporations receive a pro rata payment of cash, that payment has the effect of a dividend and is to be taxed as such. The first case in this line is Commissioner v. Owens, 69 F.2d 597 (Sth Cir. 1934), where two banks merged and the shareholders of the smaller bank received pro rata both stock in the new bank and cash. The court held that “so much of [the cash] as might before consoli- dating have been declared by their corpevation as an or- dinary dividend out of its profits is by [the predecessor of Section 356(a)(2)] to be so taxed” (69 F.2d at 598). The court specifically noted (/bid.): “It is true that the money was not distributed by the [acquired bank] and thus was not literally a dividend of that bank. But the statute speaks of a distribution which ‘has the effect of the distribution of a dividend.’ This pro rata payment to all stockholders of the [acquired bank] * * * certainly has that effect.” Subsequent to Owens, several other courts of appeals reached the same conclusion regarding boot received on a pro rata basis. See King Enterprises, Inc. v. United States, 418 F.2d at 521 (“The distribution on a pro rata basis, en- tailing no substantially disproportionate change in the continuing equity interests of the Tenco stockholders, con- stitutes a classic example of a transaction having the effect sm eee 15 of the distribution of a dividend.”)% Hawkinson v. Corm- missioner, 235 F.2d at 751 (“the distribution had all the earmarks of a taxable dividend, i.e., a pro rata disiribu- tion out of corporate earnings and profits”); Campbell v. Commissioner, 144 F.2d at 182 (“We [previously] held that when cash was distributed in a reorganization to the stock holders of the predecessor company that part of the amount thus distributed which equalled the accumulated earnings of the predecessor corporation had the effect of a taxable dividend and was accordingly taxable as such.”); see also Ross v. United States, 173 F. Supp. 793, 798 (Ct. Cl.), cert. denied, 361 U.S. 875 (1959); Rose v. Little In- vestment Co., 86 F.2d 50 (Sth Cir. 1936); Commissioner v. Forhan Realty Corp., 75 F.2d 268 (2d Cir. 1935); Sheldon v. Commissioner, 6 T.C. 510 (1946); Woodsaeard v. Coim- missioner, 30 B.T.A. 1216, 1229-1230 (1934); Woodward v. Commissioner, 23 B.T.A. 1259 (1931).? On the other hand, where the cash payment was not pro rata to the shareholders of one of the corporations, but rather was made only to holders of preferred stock who did not own any common stock in order to call and retire that preferred stock, the payment was held not to have the effect of a ¥ All of these cases, like the present one, involve “A” or “C” reorganizations of corporations not under common control. There are many more cases requiring dividend treatment tor boot received in a “D” reorganization (“a transfer by a corporation of all or a pari of ils assets to another corporation if immediately after the transter the transferor, or one or more of its shareholders * * * is in control of the corporation to which the assets are transterred,” I.R.C. § 368 (aX(l)(D)). See, e.g., DeGroff v. Commissioner, 444 F.2d 1385 (Own Cir. 1971); Liddon v. Commissioner, 230 F.2d 304 (6th Cir.), cert. denied, 352 U.S. 824 (1956); Lewis v. Commissioner, 176 F.2d 646 (Ist Cir. 1949); Love v. Commissioner, 113 b.2d 236 (3d Cir. 1940); cf. Pridemark, Inc. v. Commissioner, 345 '.2d 35 (4th Cir. 1965). 16 dividend. /Jdaho Power Co. v. United States, 161 F. Supp. 807 (Ct. Cl.), cert. denied, 358 U.S. 832 (1958). This line of authority was capped by Shimberg v. United States, supra, which rejected the precise contention accepted by the court below (see pages 6-8, supra). See also General Housewares Corp. v. United States, 615 F.2d 1056, 1066 (Sth Cir. 1980).'° Indeed, the existence of this established line of authority was noted approvingly by this Court in Commissioner v. Estate of Bedford, 325 U.S. 283 (1945). That case dealt with a factual situation somewhat different from the one here. The estate in Bedford was a shareholder of a cor- poration that engaged in a recapitalization or “E” re- organization. In exchange for 3,000 shares of preferred stock, the estate received 3,500 shares of a lesser preferred, 1,500 shares of common stock, and $45,240 in cash. The Court held thai the cash came out of the corporation’s ac- cumulated earnings and hence had the effect of a dividend and was taxable at ordinary, rather than capital, gain rates. The court referred with approval to several of the cases cited above requiring dividend treatment in the case of reorganizations involving two corporations, and it Stated (id. at 291): “We cannot distinguish the two situa- tions and find no implication in the statute restricting [the predecessor of Section 356(a)(2)] to taxation as a dividend '’ These cases uniformly recognize that dividend treatment does not turn upon which corporation physically pays out the cash to the shareholders. Whether the immediate scurce of the cash is the acquir- ing corporation, the acquired corporation, or the new corporation, a pro rata distribution to the shareholders of one corporaiion is a divi- dend to the extent of the accumulated earnings and profits of that lat- ier corporation. See Shimberg v. United States, 577 F.2d at 289; Ross v. United States, 173 F. Supp. at 798; Campbell v. Commissioner, 144 F.2d at 182; Commissioner v. Owens, 69 F.2d at 598; Woodward v. Commissioner, 23 B.T.A. at 1362. 17 only in the case of an exchange of stock and assets of two corporatins.” !! Agains:. this uniform body of decisional law, the court below erroneously relied upon Wright v. United States, 482 F.2d 600 (8th Cir. 1973), which arose in a very dif- ferent factual context. Wright was the principal share- holder in three different corporations engaged in construc- tion and equipment leasing. Wright owned 71.5% of the stock of the construction company, and his field superintendent owned 27.9%. They wanted to merge the other two companies and create a new company (Omni) that would have a stock ownership ratio similar to that of the construction company. A simple stock-for-stock reorganization, however, would have given Wright a greater share of Omni than he desired. Therefore, the merger plan provided that, in addition to the exchange of '! In the course of rejecting an alternative argument made by the estate, the Court made the statement that “a distribution, pursuant to a reorganization, of earnings and profits ‘has the effect of a distribu- tion of a taxable dividend’ ” (325 U.S. at 292). This statement was read by some as establishing an “automatic dividend” rule that would accord dividend treatment to any cash received on a reorganization, whether pro rata or »0t. This “automatic dividend” rule was heavily criticized by the commentators (see, e.g., Shoulson, Boot Taxation: The Blunt Toe of the Automatic Rule, 20 Tax L. Rev. 573 (1965); Dar- rell, The Scope of Commissioner v. Bedford Estate, 24 Taxes 266, 268-276 (1946)). The post-Bedford cases in this area, however, have rejected this broad reading and have concluded that this Court was not attempting to establish a rule that would extend to cases not in- volving a pro rata distribution, which was not what was involved in Bedford. See Shimberg v. United States, 577 F.2d at 290 & n.19; King Enterprises, Inc. v. United States, 418 F.2d at 520; Hawkinson vy. Commissioner, 235 F.2d at 750-751; Ross v. United States, 173 F. Supp. at 797. The IRS has also rejected this broad reading of Bedford. See Rev. Rul. 74-515, 1974-2 C.B. 118; Rev. Rul. 74-516, 1974-2 C.B. 121. Because the present case involves a pro rata distribution of boot, the court of appeals erred in suggesting (App., infra, 1la-12a) that the government’s contention here seeks to “resurrect{ |] the abandoned automatic dividend rule of Bedford.” 18 stock in the two old companies for stock in Omni, the superintendent would purchase additional shares of Omni and Omni would issue a promissory note to Wright. This promissory note was boot, and the court of appeals re- jected the Commissioner’s contention that it had the effect of a dividend. The court noted that “[t]he corporations in- volved did not exist separately but were owned and con- trolled by the same shareholders but in different propor- tions” (id. at 607). On that basis, the court concluded that “the note was issued by Omni in exchange for a portion of Omni stock that the taxpayer would have received if he had taken Omni stock entirely instead of receiving Omni stock and a note issued to him by Omni” (ibid.). The court then applied the provisions of Section 302 to measure the effect of this hypothetical redemption on Wright’s interest in Omni and concluded that there was a meaningful reduc- tion in his percentage interest that precluded dividend treatment. The Fifth Circuit in Shimberg recognized that Wright was distinguishable because the commonality of owner- ship of the merging corporations appeared to . > the basis upon which the Eighth Circuit had concluded that the distribution of boot should be treated like a redemption of shares in a single corporation. The Fifth Circuit therefore remarked (577 F.2d at 287): “Even assuming that Wright is correctly decided —a point on which we express no opin- ion —the instant case presents radically different facts and calls for correspondingly different analysis.” That obser- vation is equally applicable here. For this reason, the court of appeals below clearly erred in applying the “hypothetical redemption” approach of Wright to this case, rather than the long line of authority requiring divi- dend treatment for boot distributed to the shareholders of One corporation On a pro rata basis. 4. Inthe words of the Fifth Circuit in Shimberg, it was error for the court below to embrace “the undifferenti- ating invocation of stock redemption principles in a re- 19 Organization case such as this one” (577 F.2d at 287). To be sure, there is considerable similarity between the redemption provisions and Section 356(a)(2) -awe=eke reuemptten- The taxpayer in Zenz wished to sell all the stock in a corporation in which she was the sole stockholder. To satisfy the wishes of the pur- chaser who did not want to buy all the stock of the corporation, the parties agreed upon a plan under which the purchaser bought pari ot the stock and the corporation redeemed the remaining shares. The court viewed the steps in the transaction as part a single integrated plan intended to totally liquidate the taxpayer’s holdings in the cor- poration. In light of this, the court held that redemption was noi essentially equivaleni to a dividend because it completely terminated her interest in the corporation. See 213 F.2d at 917. ‘* lt should be noted that, at trial, respondent considered the redemption and exchange to be separate transactions and therefore conceded that the exchange constituted a tax-free reorganization under sec. 368(a)(1)(B). 52 T.C. at 86. However, in Rev. Rul. 75-360, 1975-2 C.B. 110, the respondent recognized that — i Was In error in argying the various sieps were separate trans- actions thereby affording tax-free treatment on the siock ev- change. Accordingly, since the acquisition was not solely tor : 33a payer, we recognized that “The record in this case establishes clearly that the redemption was merely a step in the plan of Borden for the acquisition of E&M, so that tt is the results of the plan that are significant to us.” 52 T.C. at 87 (emphasis added). We concluded that “Taking into ac- count all the circumstances of this case * * * the redemp- tion and the reorganization effected such a substantial change in the petitioner’s interest in E&M as to establish that the redemption was not essentially equivalent to a dividend.” 52 T.C. at 89. We recognize that some argument can be made that the same failure to apply the step-transaction doctrine exists in applying the Wrighz test in that such test involves viewing the cash payment as being in redemption of an imputed number of shares of the acquired corporation after the reorganization has occurred. See Rands, supra note 4, al 102-103. But we think this argument fails in that the Wright test treats the cash payment as the equivalent of a redemption in the course of implementing the reorganiza- tion, while the Shimberg test, advocated by respondent, requires that the redemption by the acquired corporation be treated as having occurred prior to and separate from the reorganization. Clearly, the cash payment in situations of the type involved herein would not have taken place without the reorganization. The same cannot be said of the redemption created by the SAimberg test. In view of the foregoing, we conclude that the deter- mination of whether the cash payment to petitioner had “the effect * * * of a dividend” should be viewed and tested within the context of the entire reorganization. To hold otherwise, and view and test the cash (boot!) as if il were distributed as a hypothetical redemption by BASIN prior to the reorganization, would in effect resurrect the voting stock of the acquiring corporation, but partly for cash, that the acquisition of stock of E&M did not consiitute a reorganization. - Therefore * * * the entire transaction ts: con: sidered a taxable sale or exchange.” 34a now discredited “automatic dividend rule” (see pp. 143-144 supra), at least with respect to pro rata distribu- tions made to an acquired corporation’s shareholders pur- suant to a plan of reorganization. We turn now to the question whether petitioner, as a result of the reorganization, suffered a reduction in in- terest sufficient to qualify the cash he received as a redemption under section 302(b). In resolving this ques- tion, we apply the test enunciated in Wright v. United States, supra, and look at the effect of the reorganization on petitioner’s potential and actual interest in NL, the ac- quiring, 1.€., surviving, corporation. '5 Pursuant to the plan, petitioner received 300,000 shares of NL common stock, which constituted approximately 0.92 percent of the total shares outstanding of NL com- mon stock after the merger. If petitioner had accepted the all stock offer, he would be received 425,000 shares of stock, which would have constituted approximately 1.3 percent of NL’s total shares outstanding. By treating the cash “boot” as a redemption of petitioner’s shares, we find that the cash distribution reduced petitioner’s interest in NL by approximately 29 percent (from 1.3 percent to 0.92 percent) so that his post-distribution holdings were only approximately 71 percent of what they would have been absent the distribution. Coupled with the fact that peti- 'S We recognize that it is possible to construe our opinion in McDonald v. Commissioner, 52 T.C. 82 (1969), as adopting a test based upon a comparison of a taxpayer's stock interest in the acquir- ing corporation with his prior interest in the acquired corporation. However, we think it significant that McDonald was decided prior to either Wright or Shimberg, that the isswe before this Court was simply whether the redemption was separate from, or an integral part of, the reorganization, and that it appears that the acquired versus acquiring corporation test for applying sec. 356fa)(2) was not presented to us Such being the case, and particulariy since the result ip McDonald would have been the same under the Wright test, we do nox view our opinion in McDonald as inhibiting our freedom to choose the test which should be applied herein. | . 35a tioners held less than 50 percent of the voting stock of NL after the redemption, under section 302(b)(2) the distribu- tion qualifies as being “substantially disproportionate” and is not taxable as a dividend. Since the distribution falls within the mechanistic “safe harbor” of section 302(b)(2), we need not decide if the redemption resulted in a mean- ingful reduction of petitioner’s stock interest under section 302(b)(1). In point of fact, respondent does not argue that the re- quired reduction in petitioner’s interest does not exist if the Wright test is applied. Rather, the heart of respondent's position is that use of the Wright test results in an “automatic capital gain” rule. Respondent argues that, in cases involving factual circumstances similar to the instant case, in which the “whale” swallows the “minnow” and gives the shareholders of the acquired corporation a pro rata distribution of boot in addition to stock, those shareholders will always be afforded capital gain treat- ment. He reasons that if a shareholder in a small closely held corporation exchanges his interest in that corporation for what must be, almost by definition, a much smaller percent of ownership in a large publicly held corporation, a comparison of these percentage ownership figures will always be so disparate as to qualify as a meaningful reduc- tion or as substantially disproportionate in the context of a edemption by the acquiring corporation. In effect, respondent’s position is rooted, as was that of the District Court in Shimberg v. United States, 415 F. Supp. 832 (M.D. Fla. 1976), in an erroneous equating of the Wright test with a comparison of a taxpayer’s interest in the ac- quired corporation before the reorganization with his in- terest in the acquiring corporation after the reorganiz- ation. See pp. 147-150 supra. We think we have made it clear that the Wright test does no such thing. It simply compares the stock interest which a taxpayer actually receives in the acquiring, i.e., surviving, corporation in a 36a reorganization with what he would have received if he had obtained additional stock in lieu of the cash payment. Whether the results of such a comparison indicate divi- dend or capital gain treatment will vary, depending on the facts and circumstances of each individual case. We think it signi ficant that respondent in substance accepts the facts and circumstances limitation in situations involving sec- tion 356(a)(2).'* In so doing, he reflects the same uncer- tainties as those of the Fifth Circuit in Shimberg v. United States, supra—uncertainties which, in a sense, are also present in Our reservation of the same limitation in adopt- ing the Wright test.'? ‘© We quote from respondent’s brief (p. 27): “We are only addressing in this brief a factual situation which is identical to the one present in Shimberg where a small corpora- tion (the “minnow”) was merged into a large corporation (the “whale”), there had been no previous commonality of ownership between the two corporations, the “minnow’s” shareholders received cash and stock on a pro rata basis, the “minnow’s” shareholders stock Ownership in the “whale” was very small vis-a- vis the number of shares outstanding, and the acquired corpora- tion had a significant amount of accumulated undistributed earn- ings and profits.” In connection with the facts and circumstances limitation, we observe ihat respondent objected at trial to the relevancy of any tesumony regarding the merger negotiations. We overruled respondent’s objection and reserved to respondent the right to argue the question of admissibility on brief. We are satisfied that we should adhere to our ruling at trial. See McDonald v. Com- missioner, 52 T.C. 82, 88 (1969). r It is interesting to note that the Court of Appeals in Wright vy. United States, 482 F.2d 600 (8th Cir. 1973), would have reached a dif- ferent conclusion if the attribution rules of sec. 318(a) had been ap- plied. See 482 F.2d at 610. See also Kyser, supra note 4, at 312 n. 78 Under sec. 227(b) 9f the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, 96 Stat. 324, 492, the attribution rules of sec. 318 now apply to “boot” payments falling within sec. 356(a). 37a While we are satisfied that the Wright test should not be equated with the comparison erroneously made by the District Court in Shimberg v. United States, supra, we think that the minnow-whale scenario is a background ele- ment which can be taken into account. Cf. McDonald v. Commissioner, supra. See also supra note 15. If we look at the particular facts and circumstances of the instant case, the correctness of our conclusion that the cash distribution of $3,250,000 did not have “the ef- fect * * * of a dividend” under section 356(a)(2) becomes even clearer. There is not the slightest evidence that the cash payment was a concealed distribution from BASIN. '* Indeed, it is hard to conceive that such a possibility could even have been considered, for a distribution of that amount was not only far in excess of the accummulated earnings and profits ($2,319,611), but also of the total assets of BASIN ($2,758,069). In fact, only if one takes in- to account unrealized appreciation in the value of BASIN’s assets, including good will and/or going-concern value, can one possibly arrive at a $3,250,000. Such a dis- tribution could only be considered as the equivialent of a complete liquidation of BASIN, which would call for capital gain treatment under Zenz v. Quinlivan, supra. Moreover, the record herein makes i clear that it was NL which developed the stock plus cash alternative and that iis foundation was attributable to a desire of NL to mini- mize the number of shares outstanding. In this connec- tion, we think that the question of whether the share- holders of the acquired corporation are given a choice '* Iw is in this context that the facts and circumstances analysis might well produce a different result when there ts persuasive evidence of an identity between the amount of the cash payment, the earnings and profits of the acquired corporation, and available liquid assets to support the conclusion that the acquiring corporation was a conduit for the payment. Cf. Ross v. United States, supra note 7. The problem of identification of the source of a cash payment is not without its dif- ficulties. See Levin, Adess & McGaffey, supra, note 4, at 290 n. 15. 38a between all stock and stock plus cash in the acquired cor- poration is not the significant factor. See McDonald y. Commissioner, supra at 89. As a general rule, we would apply the Wright test where only the latter offer was available. However, the source of the offer in whatever form may be a fact and circumstance to be taken into ac- count in certain situations. See supra note 18. Our analysis of the issue before us herein has convinced us that neither the Shimberg test nor the Wright test can be inexorably applied to “boot” distributions in connection with a reorganization, fully within which the ambit of sec- tion 356(a)(2). Each test has its supporting and criticizing arguments. See, e.g., Kyser, supra note 4; Rands, supra note 4; Levin, Adess & McGaffey, supra note 4; Com- ment, supra note 4. However, we think that, on balance, the Wright test is the more suitable vehicle for decision principally because its application produces a result more within the scope of the type of reorganization Congress had in mind in enacting section 356(a)(2), i.e., where there is an overlapping of ownership between the acquired and acquiring corporations, than the Shimberg test which would tend to produce exactly the opposite result. Moreover, unlike the Wright test, the Shimberg test would make the result dependent upon which corporation, the acquired or the acquiring, survived a merger. Indeed the deficiencies in the Shimberg test are sufficient to cause its supporters to suggest that the Wright test be applied whére there is a “commonality” of ownership of the acquired and acquiring corporations and the Shimberg test be reserved for situations where such commonality does not exist. See, e.g., Kyser, supra note 4, at 331; Rands, supra note 4, at 116. We have difficulty in applying such a bifurcated ap- proach to a statute which seems to make no distinction between different reorganizations. Cf. American Manufacturing Co. v. Commissioner, 55 T.C. 204, 230-231 (1970); Levin, Adess & McGaffey, supra note 4, ee 39a at 306. Furthermore, such an approach would add another difficult dimension to the application of section 356, i.e., determining how much overlap of stock ownership would constitute commonality. See Kyser, supra note 4, at 329-332. One final word. The root of the problem of choice be- tween the Wright test and the Shimberg test lies in the low level of “continuity of interest” required to constitute a type of tax-free reorganization. The result of this low-level requirement is to cause transactions to be treated as reorganizations which really should be considered sales, i.e., where there is a substantial amount of cash paid and/or the stock of the acquiring corporation can be readily disposed of by the taxpayer. See, e.g., Kyser supra note 4, at 315 n. 90 and 340. But this condition has existed far too long for the judiciary now to change the rules of the game. If a change is to come, it must come from the legislature. We think the same is true with respect to adopting a bright-line test, under section 356(a)(2), i.e., a rule applicable without qualification to all cases, to deter- mine whether a distribution has “the effect * * * of a divi- dend.” In the meantime, the courts, the Executive, and taxpayers will be forced to live with a test which admitted- ly is imprecise in that it will not be inexorably applicable in all situations. To reflect the foregoing and petitioners’ concessions on other issues, Decision will be entered under Rule 155. Reviewed by the Court. STERRETT, GOFFE, NIMS, PARKER, Wit AKER, KORNER, SHIELDS, HAMBLEN, COHEN, CLAPP, Swirt, JACOBS, WRIGHT, and WILLIAMS, JJ., agree with this opinion. SIMPSON, WILBUR, CHABOT, GERBER, and Parr, JJ., did not participate in the consideration of this case. 40a APPENDIX © UNITED STATES COURT OF APPEALS FOR THE FOURTH CIRCUIT No. 86-1736 DONALD E. CLARK; PEGGy S. CLARK, PLAINTIFFS-APPELLEES Vv. COMMISSIONER OF INTERNAL REVENUE DEFENDANT-APPELLANT Appeal from the Tax Court of the United States [Filed: September 4, 1987] JUDGMENT bi cause came on to be heard on the trancript of the ecord trom The Tax Court of the United States, and was argued by counsel. Par consideration whereof, it is now here ordered and : ju ged by this Court that the decision of said The Tax | ourt ot the United States, in this cause, be, and the same is hereby, affirmed. /s/ JOHN M. GREACEN John M. Greacen Clerk A True Copy, Teste: * John M. Greacen, Clerk By: BARBARA RAvi Deputy Clerk 4la APPENDIX D The Internal Revenue Code (26 U.S.C.) provides in pertinent part: Section 302. Distributions in redemption of stock (a) General rule If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part of full payment in exchange for the stock. (b) Redemptions treated as exchanges (1) Redemptions not equivalent to dividends Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend. (2) Substantially disproportionate redemption of stock (A) In general Subsection (a) shall apply if the distribution is substantially disproportionate with respect to the shareholder. (B) Limitation This paragraph shall not apply unless immediately after the redemption the shareholder owns less than 50 percent of the total combined voting power of all classes of stock entitled to vote. (C) Definitions For the purposes of this paragraph, the distribution is substantially disproportionate if — (i) the ratio which the voting stock of the cor- poration owned by the shareholder immediately after the redemption bears to all of the voting stock of the corporation at such ume, is less than 80 percent of — ®t 42a (ii) the ratio which the voting stock of the cor- poration owned by the shareholder immediately before the redemption bears to all of the voting stock of the corporation at such time. For purposes of this paragraph, no distribution shall be treated as substantially disproportionate unless the shareholder’s ownership of the common stock of the corporation (whether voting or nonvoting) after and before redemption also meets the 80 percent require- ment of the preceding sentence. For purposes of the preceding sentence, if there is more than one class of common stock, the determinations shall be made by reference to fair market value. (D) Series of redemptions This paragraph shall not apply to any redemption made pursuant to a plan the purpose or effect of which is a series of redemptions resulting in a distribution which (in the aggregate) is not substan- tially disappropriate with respect to the shareholder. (3) Termination of shareholder’s interest Subsection (a) shall apply if the redemption is in com- plete redemption of all of the stock of the corporation owned by the shareholder. (4) Redemption from noncorporate shareholder in partial liquidation Subsection (a) shall apply to a distribution if such distribution is — (A) in redemption of stock held by a shareholder who is not a corporation, and (B) in partial liquidation of the distributing cor- poration. (5) Application of paragraphs in determining whether a redemption meets the re- quirements of paragraph (1), the fact that such redemp- | | 43a tion fails to meet the requirements of paragraph (2), (3), or (4) shall not be taken into account. If a redemption meets the requirements of paragraph (3) and also the require- ments of paragraph (1), (2), or (4), then so much of subsection (c)(2) as would (but for this sentence) apply in respect of the acquisition of an interest in the corporation within the 10-year period beginning on the date of the distribution shall not apply. Section 316. Dividend defined (a) General rule For purposes of this subtitle, the term “dividend” means any distribution of property made by a corporation to its shareholders — (1) out of its earnings and profits accumulated after February 28, 1913, or (2) out of its earnings and profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made. Except as otherwise provided in this subtitle, every distribution is made out of earnings and profits to the ex- tent thereof, and from the most recently accumulated earnings and profits. To the extent that any distribution ts, under, any provision of this subchapter, treated as a distribution of property to which section 301 applies, such distribution shall be treated as a distribution of property: for purposes of this subsection. Section 317. Other definitions (a) Properiy For purposes of this part, the term “property” means money, securities, and any other property; except thal such term does not include stock in the corporation mak- ing the distribution (or rights to acquire such stock). 44a 45a (b) Redemption of stock then the gain, if any, to the recipient shall be _— For purposes of this part, stock shall be treated as nized, but in an amount not In excess of the sum of such redeemed by a corporation if the corporation acquires its money and the fair market value of such other property. stock from a shareholder in exchange for property, (2) Treatment as dividend whether or not the stock so acquired is cancelled, retired, if an exchange is described in paragraph (1) but has or held as treasury stock. the effect of the distribution of a dividend (determined Section 354. Exchanges of stock and securities in certain with the application of section 318(a)), then none reorganizations. | be treated as a dividend to each distributee such an (a) General rule amount of the gain recognized under paragraph (1) as 1s not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be treated as | gain from the exchange of property. * * 7 x * (1) /n general No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, ex- changed solely for stock or securities in such corpora- tion or in another corporation a party to the reorganiza- tion. en * x * x * (3) Cross referenee (A) For treatment of the exchange if any property is received which is not permitted to be received under this subsection (including an excess principal amount of securities received over securities surrendered, but not including property to which paragraph (2)(B) applies), see section 356. Section 356. Receipt of additional consideration (a) gain on exchanges (1) Recognition of Gain If— (A) section 354 or 355 would apply to an exchange but for the fact that , (B) the property received in the exchange consists not only of property permitted by section 354 or 355 to be received without the recognition of gain but also of other property’ or money, US GOVERNMENT PRINTING OFFICE 1986~ 202 037/002 10 --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385012_0634%3A2. Public record. Not legal advice.